Acquisition Accounting: Definition & How It Works
Throughout the United States, the Generally Accepted Accounting Principles (GAAP) must be followed. The principles are guidelines to help accounting standards be more transparent and accurate but within these accounting standards, there is more to know and understand for specific types of accounting.
Acquisition accounting is a perfect example. So how does it work? Read on to learn more. We’ll dive into understanding assets and liabilities, the foundation of acquisition accounting, and more!
Table of Contents
- Acquisition accounting refers to a method used to report certain components of a business purchase.
- It’s important to understand the differences between the purchase and pooling methods.
- Fair market value records assets and liabilities under the asset purchase method.
- Companies prefer to use the purchase method over the pooling method.
What Is Acquisition Accounting?
Acquisition accounting is a method of reporting certain parts of a business sale. Parts like liabilities, assets, goodwill, and non-controlling interest make up this accounting framework. As a business owner, you must include such factors in your financial statements.
The resulting intangible assets are usually recorded at their fair value. The consideration paid to the seller may include cash, debt, equity, or other assets. The amount and type of consideration paid affect the acquirer’s financial statements.
For example, if a company pays cash for an acquired business, its cash flow balance will decrease. If a company issues equity to the seller, its share capital will increase. The accounting for acquisitions can be complex. But it is important to understand the financial position of a company.
When a company acquires another, there are often two ways to account for the transaction. The first is the purchase method. This involves recording the acquired company’s assets and liabilities. The acquirer company must do so at their fair market value at the acquisition date.
The second is the pooling of interests method. This generally results in less favorable accounting treatment for the acquired company. As such, most companies prefer these allocation methods when acquiring another company.
How Does Acquisition Accounting Work?
The main benefit of acquisition accounting allows for a fair value analysis of the acquired assets and liabilities. This fair value analysis provides greater transparency into the financials of the business. This can prove helpful in making informed decisions about the business.
Acquisition accounting can also provide tax benefits. It enables businesses to defer taxes on acquired assets and liabilities. The cost accounting rules of acquisition accounting can be a complex process. But the benefits can be well worth the effort. This is true for businesses looking to better understand their financials.
Acquisition accounting provides fair value for acquired assets and liabilities. This process generally involves five main steps:
- Identifying the tangible assets and liabilities of the company
- Identifying the intangible assets and liabilities of the company
- Valuing the non-controlling interest in the company
- Allocating the consideration paid to the seller
- Goodwill allocation process
When a company acquires another company, there are many items that need to be accounted for. You can find these on the balance sheet and income statement. Tangible assets and liabilities, such as inventory and buildings, are easy to value.
But what about intangible assets and liabilities? What is an intangible asset definition? This refers to patents and goodwill, which are more difficult to quantify. The non-controlling interest of the acquired company isn’t owned by the acquiring company.
Understanding Assets and Liabilities
Accountants must identify the acquired company’s tangible assets and liabilities. They do this by reviewing the company’s balance sheet. This will give them a starting point for valuing the assets and liabilities.
Once they have a list of the assets and liabilities, they will need to assign a value to each one. The value depends on either the market value or the fair value as of the date of acquisition.
After that, accountants focus on intangible assets and liabilities. These can be more difficult to value because they are not physical assets.
Yet some common examples of intangible assets include goodwill, patents, and copyrights. Intangible assets are often valued using a discount rate that reflects their riskiness and expected life.
The consideration paid to the seller is the price that the acquirer company pays for the acquired company. Goodwill is an intangible asset. It represents the value of the acquired company over and above its tangible assets and liabilities.
Acquisition accounting can be complex. But it is critical to value a company after an acquisition. Proper accounting assures a company can be sure that it is making a sound investment.
There are many benefits of acquisition accounting. For example, it ensures fair treatment of buyers and sellers. It also creates a level playing field.
Other notables include providing valuable information to investors and other stakeholders. It also provides a fair value analysis of the acquired assets and liabilities.
Acquisition accounting also includes any acquired goodwill. Goodwill is a vital intangible asset that can add considerable value to a company.
As such, it is important to be aware of the fair value of goodwill when considering an acquisition. It would be hard to assess the benefits and drawbacks of acquisitions without them.
The Foundation of Acquisition Accounting
The basics of acquisition accounting are a set of rules and practices. They get used when one company purchases another. This was first conceived by the Financial Accounting Standards Board (FASB). This is the organization that sets these rules and guidelines.
There are two main ways to account for an acquisition. These are the purchase method and the pooling of interests method.
This is when the acquiring company records the assets and liabilities of the acquired company. They must do so at their fair market value.
Pooling of Interests Method
This is when the two companies combine their financial statements. It’s as if they had always been one company. This method is only used if both companies have common ownership.
Moreover, there are also several different types of acquisition. For example, cash acquisitions, stock acquisitions, and asset acquisitions.
In a cash acquisition, the buyer pays for the acquired company with cash. In a stock acquisition, the buyer pays for the acquired company with stock.
In an asset acquisition, the buyer only purchases some of the assets of the acquired company. There’s also the decision of which accounting method to use and which type of acquisition to make. These things depend on many factors. For example, the size of the companies involved and the purpose of the acquisition.
Mergers and Acquisitions
Acquisition accounting can be complex. And the current accounting rules may not always provide the level of transparency desired in a merger or acquisition.
It’s important to consider the impact of acquisition accounting on the financial statements. In doing so, it is possible to improve the overall transparency of the transaction. Acquisition accounting can provide valuable insights into the true cost of the transaction. The same is true for the allocation of the purchase price to the underlying assets.
This information provides shareholders with complete information about the financials of the acquisition. Greater transparency into the complexities of acquisition accounting is essential. Investors can then make informed decisions about whether to support a particular transaction.
As you’ve seen, there are economic benefits associated with acquisition accounting. The key is to identify and quantify those benefits. But you must do so soon after the acquisition. This enables management to make better decisions about allocating business resources.
One way to do this is to look at contingent considerations. This is an important tool in acquisition accounting. You can identify and quantify economic benefits that may not be immediately clear.
For example, suppose you are acquiring a business to enter a new market. The contingent consideration may include the economic benefit of the new market entry. By including this in acquisition accounting, you can better assess the economic benefits.
Frequently Asked Questions about Acquisition Accounting
Acquisition costs refer to the total sum of expenses incurred in an acquisition. Your accountant records this total after deducting closing costs and any applicable discounts.
Acquisition cost is always listed under fixed assets. This includes excess purchase price costs, as well. For example, this would be any extra expenses needed to get your new assets working properly.
The acquisition method refers to the total cost of the sale. The purchase method refers to the total value of assets acquired.
This is simply a financial statement used in an asset acquisition transaction.
Expensed costs reflect a business acquisition. Capitalized costs refer to an asset acquisition.
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